Sell-Off in Costco Wholesale Corporation (COST) Stock Is a Golden Opportunity

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Amazon.com, Inc. (NASDAQ:AMZN) is coming, and there is nothing Costco Wholesale Corporation (NASDAQ:COST) or COST stock can do about it.

Sell-Off in Costco Wholesale Corporation (COST) Stock Is a Golden Opportunity

At least that is what the market appears to be saying after it  sent COST stock down more than 6%, despite the company reporting very strong fourth quarter results.

And maybe it’s true. Maybe Amazon will turn Whole Foods Market, Inc. (NASDAQ:WFM) into a Costco-killer. But the numbers don’t support that bear thesis.

Comparable sales were up 3.8% last year, up 5.7% last quarter and up 6.2% last month. E-commerce sales were up 13% last year, 21% last quarter and 30% last month. Operating margins expanded nearly 20 basis points last quarter. Earnings per share rose nearly 18%.

Those numbers are about as good as it gets for Costco over the past 5 years.

But COST stock trades at just 26 times trailing earnings. The 5-year average trailing price-to-earnings multiple for COST stock is around 27 to 28.

I think this means there is an opportunity to buy the dip on a stock that is being beaten up on irrational fears related to Amazon.

No Red Flags At Costco

Costco reported blowout numbers, but the stock is selling off for a few reasons:

  • Membership renewal rates are dropping.
  • The new member sign-up rate is slowing.
  • Memberships per location are falling.

Costco is also behind in the delivery game, and the fact the company is now playing catch-up could be interpreted as a defensive move.

Plus, this is a stock that, historically, has traded at a premium valuation. Now, investors are starting to question whether that premium is warranted.

All of these questions have reasonable answers.

Renewal rates are stagnant because of a credit card switch, and management believes these issues are short-term in nature. After all, the same thing happened in Canada, where a similar switch in fiscal 2015 caused renewal rates to drop a full percentage point. Today, renewal rates in Canada are higher than they were pre-conversion. The same thing will likely happen in the US. No red flags here.

Meanwhile, the new member sign-up rate is slowing almost exclusively due to timing. Simply, the more warehouses Costco adds in new markets, the bigger its sign-up rate. The positive takeaway here is that the trend of 60,000 new members per new opening remained intact in the fourth quarter. No red flags here.

Memberships per location are falling mostly due to cannibalization. The opening of a new warehouse near an existing warehouse adds to the overall membership base and adds about $80 million to $100 million of new annual sales in that market, but it also dilutes the per-location membership figures by about 10,000. That is a risk worth taking considering the incremental revenue add. Again, no red flags here.

Finally, Costco is unquestionably behind in the delivery game, but it doesn’t really matter. Just look at sales and traffic trends. Comps are strongly positive and trending up. Traffic is strongly positive and trending up. Clearly, Costco hasn’t needed delivery yet to drive positive top-line trends. The value prop of an affordable and convenient all-in-one shopping destination is more than enough.

Nonetheless, Costco is upping its game in the delivery market. Maybe the moves are defensive, but maybe they are just another growth opportunity for this retail behemoth. After all, it’s not like comps and earnings are falling and Costco has its back against the wall. Considering how robust the growth numbers are currently without great delivery operations, the delivery roll-out feels more like an offensive move than a defensive one.

Bottom Line on COST Stock

There aren’t any glaring red flags at Costco. Investors just seem to be a little jumpy considering Amazon is breathing down Costco’s neck.

But Costco isn’t feeling the pressure. Whole Foods price cuts came at the end of August. That means September was the first full month of operations for grocery players in this new promotional environment.

Costco had a killer September. US comparable sales rose 7.1%. That is much higher than previous numbers (6.1% in August, 5.5% in July, and 6.3% in June).

I understand that investors don’t want to keep paying a premium for COST stock now that the company is facing a long-running headwind in Amazon. But if the long-running headwind proves to be really small in nature, then investors will gladly get back into the mindset of paying a premium for COST stock.

I think that is exactly what will happen. Amazon is much less of a threat to Costco than the market thinks. The more Costco continues to report robust growth numbers, the more the market will realize this. The more the market realizes this, the higher COST stock will go.

Patience is the name of the game here.

As of this writing, Luke Lango was long COST and AMZN. 


Article printed from InvestorPlace Media, https://investorplace.com/2017/10/sell-off-costco-cost-stock-golden-opportunity/.

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